chapter 20: production and costs economic costs & profits short run long run economic costs...
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Chapter 20: Production and CostsChapter 20: Production and CostsChapter 20: Production and CostsChapter 20: Production and Costs
• economic costs & profits
• short run
• long run
• economic costs & profits
• short run
• long run
big picturebig picturebig picturebig picture
• understand behavior of firm
• understand & measure production costs
• understand behavior of firm
• understand & measure production costs
I. economic costs & profitsI. economic costs & profitsI. economic costs & profitsI. economic costs & profits
• firm’s goal:
maximize profit
• look at factors that affect firm’s decision
• firm’s goal:
maximize profit
• look at factors that affect firm’s decision
economic costseconomic costseconomic costseconomic costs
• opportunity cost of resources used
• explicit costs paid in money wages, rent, material, etc.
• implicit costs opportunity cost of resources used
• opportunity cost of resources used
• explicit costs paid in money wages, rent, material, etc.
• implicit costs opportunity cost of resources used
example: smoothie shopexample: smoothie shopexample: smoothie shopexample: smoothie shop
• explicit costs: wages interest on loan rent on store fruit, blenders
• explicit costs: wages interest on loan rent on store fruit, blenders
• implicit costs forgone interest on funds used to
buy capital owner’s forgone wages owner’s forgone profit from other
venture
• implicit costs forgone interest on funds used to
buy capital owner’s forgone wages owner’s forgone profit from other
venture
accounting profitaccounting profitaccounting profitaccounting profit
• total revenue – explicit costs
• ignores opportunity cost• total revenue – explicit costs
• ignores opportunity cost
economic profiteconomic profiteconomic profiteconomic profit
• includes opp. costs
= total revenue - total costs
= (price)(quantity)
- (explicit + implicit costs)
• includes opp. costs
= total revenue - total costs
= (price)(quantity)
- (explicit + implicit costs)
normal profitnormal profitnormal profitnormal profit
• occurs when
• amount of accounting profit
= opportunity costs of resources
• if earning a normal profit, economic profit = 0
• occurs when
• amount of accounting profit
= opportunity costs of resources
• if earning a normal profit, economic profit = 0
Short Run vs. Long RunShort Run vs. Long RunShort Run vs. Long RunShort Run vs. Long Run
• Short Run (SR) time frame where some resources
are fixed
-- plants, equipment some inputs variable
-- labor SR decisions are reversible
• Short Run (SR) time frame where some resources
are fixed
-- plants, equipment some inputs variable
-- labor SR decisions are reversible
• Long Run (LR) time frame where all inputs are
variable
--build a bigger plant LR decisions are hard to reverse
-- cannot easily get rid of capital
-- sunk cost
• Long Run (LR) time frame where all inputs are
variable
--build a bigger plant LR decisions are hard to reverse
-- cannot easily get rid of capital
-- sunk cost
II. SR ProductionII. SR ProductionII. SR ProductionII. SR Production
• measures of output total product marginal product average product
• measures of output total product marginal product average product
total product (TP)total product (TP)total product (TP)total product (TP)
• total quantity of good produced
in a given period
• at first, increases with labor,
then falls
• total quantity of good produced
in a given period
• at first, increases with labor,
then falls
TP: gal. of smoothies per hourTP: gal. of smoothies per hourTP: gal. of smoothies per hourTP: gal. of smoothies per hour
# workers TP
01234567
01368998
TP
# workers5 6
9
marginal product (MP)marginal product (MP)marginal product (MP)marginal product (MP)
• change in TP due to one more worker
• change in TP due to one more worker
=change in TP
change in labor
At first MP rises with workersAt first MP rises with workersAt first MP rises with workersAt first MP rises with workers
• add more workers
• greater specialization
• MP of each worker added is larger
than previous worker
• increasing marginal returns
• add more workers
• greater specialization
• MP of each worker added is larger
than previous worker
• increasing marginal returns
then, MP falls with more workersthen, MP falls with more workersthen, MP falls with more workersthen, MP falls with more workers
• keep adding workers
• but same amount of capital
• so eventually get in the way
• MP of more workers smaller than
MP of previous workers
• decreasing marginal returns
• keep adding workers
• but same amount of capital
• so eventually get in the way
• MP of more workers smaller than
MP of previous workers
• decreasing marginal returns
TP, MP: gal. of smoothiesTP, MP: gal. of smoothiesTP, MP: gal. of smoothiesTP, MP: gal. of smoothies
# workers TP
01234567
01368998
MP
1
2
3
-1
0
12
MP
Q = # workers
0
3
3
law of decreasing returnslaw of decreasing returnslaw of decreasing returnslaw of decreasing returns
• As firm uses more labor with capital fixed, MP of labor will eventually fall
• As firm uses more labor with capital fixed, MP of labor will eventually fall
Average Product (AP)Average Product (AP)Average Product (AP)Average Product (AP)
=TP
labor
= productivity
# workers TP
01234567
01368998
MP
1
2
3
-1
0
12
AP
11.5221.81.51.1
MP
# workers
0
3
3
AP
MP & APMP & APMP & APMP & AP
• MP intersects AP at max of AP
• why?
• MP > AP AP is rising
• MP < AP AP is falling
• MP intersects AP at max of AP
• why?
• MP > AP AP is rising
• MP < AP AP is falling
III. SR costIII. SR costIII. SR costIII. SR cost
• measure cost 3 ways: total cost marginal cost average cost
• measure cost 3 ways: total cost marginal cost average cost
Total Cost (TC)Total Cost (TC)Total Cost (TC)Total Cost (TC)
• cost of all factors used
• total fixed cost (TFC) cost of land, capital, etc. does not change in SR
• total variable cost (TVC) cost of labor changes in SR
• TC = TFC + TVC
• cost of all factors used
• total fixed cost (TFC) cost of land, capital, etc. does not change in SR
• total variable cost (TVC) cost of labor changes in SR
• TC = TFC + TVC
example : yogurtexample : yogurtexample : yogurtexample : yogurt
• labor = $6/ hour
• TFC = $10/ hour• labor = $6/ hour
• TFC = $10/ hour
workers TP TFC TVC TC
0 0 10 0 101 1 10 6 161.6 2 10 9.6 19.62 3 10 12 22
45
89
1010
2430
3440
Q = output
TC
TFC10
TC
TVC
Marginal CostMarginal CostMarginal CostMarginal Cost
• change in TC due to one-unit increase in output (Q)• change in TC due to one-unit
increase in output (Q)
=change in TC
change in Q
TP TFC TVC TC
0 10 0 101 10 6 162 10 9.6 19.63 10 12 22
89
1010
2430
3440
MC
63.62.4
6
Average Cost (ATC)Average Cost (ATC)Average Cost (ATC)Average Cost (ATC)
• = TC/Q
• average fixed cost (AFC) (TFC/Q)
• average variable cost (AVC) (TVC/Q)
• ATC = AFC + AVC
• = TC/Q
• average fixed cost (AFC) (TFC/Q)
• average variable cost (AVC) (TVC/Q)
• ATC = AFC + AVC
TP TFC TVC TC
0 10 0 101 10 6 162 10 9.6 19.63 10 12 22
89
1010
2430
3440
AFC AVC AC
10 6 165 4.8 9.8 3.33 4 7.33
1.25 3 4.251.11 3.33 4.44
Q = output
AC, MC
AFC
ATC
AVC
MC
MC & ACMC & ACMC & ACMC & AC
• MC intersects AC at its minimum
• MC < AC AC is falling
• MC > AC AC is rising
• MC intersects AC at its minimum
• MC < AC AC is falling
• MC > AC AC is rising
AC is U-shapedAC is U-shapedAC is U-shapedAC is U-shaped
• why?
• AFC falls with Q
• AVC falls then rises decreasing marginal returns
• so ATC falls, then rises
• why?
• AFC falls with Q
• AVC falls then rises decreasing marginal returns
• so ATC falls, then rises
cost & product curvescost & product curvescost & product curvescost & product curves
• when MP is at maximum,
MC is at minimum
• when AP is at maximum,
AVC is at minimum
• when MP is at maximum,
MC is at minimum
• when AP is at maximum,
AVC is at minimum
what shifts cost curves?what shifts cost curves?what shifts cost curves?what shifts cost curves?
• technology make more with same inputs shifts TP, MP, AP up changes ATC curve
• technology make more with same inputs shifts TP, MP, AP up changes ATC curve
• changes in factor prices increase fixed costs
-- TFC, AFC shift up
-- TC shift up increase wages (variable)
-- TVC, AVC, MC shift up
-- TC shift up
• changes in factor prices increase fixed costs
-- TFC, AFC shift up
-- TC shift up increase wages (variable)
-- TVC, AVC, MC shift up
-- TC shift up
IV. LR costsIV. LR costsIV. LR costsIV. LR costs
• all inputs (and costs) are variable
• what happens if increase plant
AND labor by 10%? ATC fall? ATC rise? ATC stay same?
• all inputs (and costs) are variable
• what happens if increase plant
AND labor by 10%? ATC fall? ATC rise? ATC stay same?
Economies of scaleEconomies of scaleEconomies of scaleEconomies of scale
• increase inputs 10% output increase > 10% ATC falls
• why? gains from specialization
-- labor
-- capital
• increase inputs 10% output increase > 10% ATC falls
• why? gains from specialization
-- labor
-- capital
Diseconomies of scaleDiseconomies of scaleDiseconomies of scaleDiseconomies of scale
• increase inputs 10% output increase < 10% ATC rises
• why? too hard to control large firm
• increase inputs 10% output increase < 10% ATC rises
• why? too hard to control large firm
Constant returns to scaleConstant returns to scaleConstant returns to scaleConstant returns to scale
• increase inputs 10% output increase = 10% ATC stays same
• increase inputs 10% output increase = 10% ATC stays same
LR Average Cost (LRAC)LR Average Cost (LRAC)LR Average Cost (LRAC)LR Average Cost (LRAC)
• lowest average cost when all inputs are variable
• SRAC curves from different plant sizes
• lowest average cost when all inputs are variable
• SRAC curves from different plant sizes
Q = output
ACATC1 ATC2
ATC3ATC4
LRAC
Q = output
ACATC1 ATC2
ATC3ATC4
economiesof scale
constantreturnsto scale
diseconomiesof scale
summary:summary:summary:summary:
• costs = implicit + explicit
• SR, only labor variable
• LR, all inputs variable
• Production & costs total, marginal, average fixed, variable
• costs = implicit + explicit
• SR, only labor variable
• LR, all inputs variable
• Production & costs total, marginal, average fixed, variable